Compound Interest
What is Interest?
Interest is defined as the amount of money paid for the use of someone else's money.
This idea works both ways when you work with a bank:
When you put your money in an interest bearing savings account
The bank pays you interest
When the bank gives you a loan
You pay the bank interest
There are many different kinds of interest but I will focus on compound interest in this article.
What is compound interest?
The principal is the original amount of money which is either borrowed (from the bank in the form of a loan) or deposited (by the individual into a savings account) and the interest is the additional charges (usually seen as a percentage over time), which makes money for both the lender (bank) or depositor (individual).
Below is an example of how compound interest can build up over multiple years:
Another example is the concept of doubling the value of a penny everyday for 30 days:
While the growth shown in this example is exaggerated it can be used to see how compound interest can build up your initial investment from a small amount to a very large sum.
Compound interest can be calculated using a formula:
There are also many online calculators (like the one below) that make this easier by allowing you to just fill out the necessary information.
https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
Lastly
Compound interest can work for or against you.
In regards to loans and credit cards: the longer you take to pay off credit card debt, the more money you will ultimately have to pay. This quickly can become a very serious problem [see section on credit cards].
In regard to savings: the longer you save (meaning the earlier you start saving) the more money you will have which is helpful for retirement among other things.
